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COST SEGREGATION & PROPERTY TAX SERVICES
April 21, 2002
Written by Cal Fugitt

For many years and in all industries, taxpayers have utilized cost segregation and purchase price allocation techniques to maximize depreciation benefits. The tax codes “Modified Accelerated Cost Recovery System” (MACRS) or previously (ACRS) has been modified over the years but is still essentially a method to accelerate depreciation. Currently under MACRS residential real property is depreciated on a straight-line basis over 27.5 years and commercial/industrial property over 39 years. Some specialized industries have specified lives such as oil & gas, utilities, farming, etc.

Under current tax law, when an income taxpayer acquires or constructs a new facility, opportunities may exist to more accurately classify and thus maximize federal and state tax depreciation. This is done by identifying 5, 7, and 15-year property typically included in allocated building or land values for acquired real estate or in construction trade accounts for newly constructed facilities. The shorter life and accelerated declining balance depreciation methods (150% and 200%) available under MACRS can generate major cash flow benefits in both current and future years for federal and for most state income tax reporting purposes. Additionally, at the time of acquisition or construction, remodeling or renovation it is often a great time to position and review one’s property tax situation.

Identification and quantification of these personal property and land improvement support costs may also be eligible for investment credit or other tax exemptions. At the local and some state levels, job creation investment credits, abatements and exemptions can further enhance state or local tax benefits.

Previous acquisitions and construction projects, which may have been overlooked, may now be worth a thorough review due to recently issued IRS Revenue Proclamation Rulings (currently Rev.Proc.2002-09) that allows retrospective identification and correction of MACRS lives.

The 2002 Federal Tax Bill recently passed allow additional depreciation (up to 30%) for qualified property acquired after September 10, 2001. This allowance increases the valid reclassification process even more. It’s a fairly simple application but significant. Individual States will differ on how this change will apply.

For property tax cost segregation purposes, tremendous benefit can be realized by identifying non-assessable categories in new construction. Items such as overtime premiums, fast track construction elements, re-work, demolition or excess tie-in costs, etc. which are included in the book and income tax basis of these projects would be an indicator of lower beginning or base year value for property tax purposes. It is important to keep in mind is that cost does not always equal value. Optimistic deal economics may not be realized initially and may warrant negotiation or appeal proceedings with local property tax authorities.

Consulting on newly acquired or constructed real property using a combined cost segregation and property tax perspective can be very advantageous. The cost segregation services for every dollar reclassified from 27.5 and 39 year into these shorter lived categories can give back 10 cents to 22 cents or more on the dollar. The positive impact on investor yields can amount to a percentage point or more. There can also be positive impact on the value of a property from increased cash flow, earnings per share (EPS), return on assets (ROA), shareholder and partnership value, etc. all from a more aggressive allowable and supportable review of these issues. Property tax benefits vary by state and even by local statute and practice. It is not unusual to find a 5% reduction of cost in a $20 Million construction project. In a 1.1% taxing district, annual saving would be approximately $11,000. These are generally benefits that taxpayers will not realize without help. Fee to measurable benefit payback can be more than ten to one for the cost segregation work and property tax work is usually only executed if savings are assured in advance with a preliminary review.

Bear in mind that these are studies that go beyond a review of the invoices or line items on a contractors cost breakdown. They may involve intensive engineering and application of knowledgeable capital cost recovery expertise. Important to note is the requirement for supportability in case of audit. The techniques mentioned above are not new but are often overlooked or performed post transaction. We believe management should be thinking about these issues while you’re lining up the architect and contractor for a new project or in the due-diligence phase of an acquisition. It can enhance the benefit and support the positions taken by involving everyone in the process. It may also save money long term by organizing and reporting costs in a format that can be readily incorporated into a cost segregation report and eventually into your organization’s fixed assets record. Property tax work can be highly specialized also. Many of the “contingency fee” providers don’t gain the perspective or double up the fee to provide their property tax service that can be done with greater efficiency along with the cost segregation work. Please call Cal Fugitt directly to find out how these techniques can help your client.

Cal Fugitt is an accredited senior member of the American Society of Appraisers (ASA) located in Sonoma, California. He served as president of the Bay Area Chapter of the ASA in 1987. Cal is a former Director with PricewaterhouseCoopers LLP, San Francisco and has practiced appraisal & valuation, construction consulting and property taxes since the early 1970’s. Cal is currently a principal in Cost Tech Consulting, a firm specializing in providing cost segregation, property records review and purchase price allocation services.